A Safer Way To Play The Biotech Sector… For A Potential 5% Gain
I keep coming back to biotech stocks, and for good reason — the trends are up and the moves are big. However, with the stock market facing an important crossroads on the charts, I want to sleep at night. Therefore, a biotech ETF is the way to go.
On Thursday, we saw some nice multi-percentage-point moves in both big- and small-cap biotech stocks. However, some of these winners are technically overextended, and while the trends are up, they can potentially draw down 5% in a heartbeat.
That is why an ETF is a good choice. Moves both higher and lower are more subdued, and if you are like me, that should appeal to your risk-control side. After all, one big blowup can erase days, if not weeks, of trading gains.
The Market Vectors Biotech ETF (NYSE: BBH) sports a nice technical pattern complete with an upside breakout. Momentum and relative performance confirm that its rising trend remains intact, but there is one problem: This ETF trades only 75,000 shares per day on average. That is a bit thin for most traders and could cause a problem if we have to sell in a hurry.
Therefore, the alternative iShares Nasdaq Biotechnology (NASDAQ: IBB) works just fine. As we can see in the chart, it just punched through a short-term declining trendline after last week’s failed attempt for the bears to drive it below the 50-day moving average.
Whereas BBH is now trading at a 20-week high, IBB is not. The difference is in the components of the two ETFs, but the real question is, does it matter? The answer is, not really. We are trying to find a sector that has the wind at its back and that sure looks to be biotech.
The initial upside potential right now is a return to the February highs in the $275 area. Percentage-wise it is not a tremendous amount, but we are looking for a conservative play. To use a baseball analogy, take care of the singles and the home runs will take care of themselves.
We have an excellent chance for a quick 5% gain in just a few weeks, and there is no reason why the bull market that has been in effect here since 2009 cannot support even higher prices thereafter. It is just a bridge we’ll cross later.
The goal is to keep risk to a minimum. We are already diversifying across many stocks by buying an ETF, and we will know right away we are wrong if the ETF moves back below its breakout level and 50-day average.
We may be thrown out at first with the ETF (getting stopped out for a small loss), but an individual, high-volatility biotech stock can easily gap down on any bit of bad news. That’s the kind of loss we want to avoid.
By diversifying, we give up some potential big gains, but we limit the effects of any sudden negative turnaround in high flyers. With the stock market showing more technical problems than it has in a long time, even through the bull market is still intact, I’ll choose steady over spectacular.
Recommended Trade Setup:
— Buy IBB at the market price
— Set stop-loss at $250
— Set initial price target at $275 for a potential 5% gain in three weeks
This article originally appeared on ProfitableTrading.com: With Market Flying Caution Flag, This Looks Like the Safer Bet
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